1.5.2a Profit maximisation and the MC=MR rule

Firms Maximise Profit Where Marginal Cost Equals Marginal Revenue

1. The traditional theory of the firm assumes firms maximise profit.
2. Profit is greatest where marginal cost equals marginal revenue.
3. Marginal cost must be rising through marginal revenue at that point.

Find the Output Where Rising MC Cuts MR, Then Read Price off the AR Curve

1. Find the output where MC cuts MR from below.
2. Read the price up to the demand (AR) curve at that output.
3. Check that marginal cost is rising, not falling, at the crossing.

In the Short Run a Loss-Making Firm Produces Only If Price Covers Average Variable Cost

1. Even at $MC=MR$, a firm may be making a loss.
2. In the short run it keeps producing only if price covers average variable cost.
3. If price falls below average variable cost, it shuts down.

State MC Equals MR and Confirm Marginal Cost Is Rising Through MR

1.5.2b Divorce of ownership and alternative objectives

As Firms Grow, Ownership Becomes Divorced from Control

1. Some firms stay small while others grow through organic or external growth.
2. In large firms, ownership is often divorced from control.
3. Owners (principals) rely on managers (agents) to run the firm.

The Principal-Agent Problem Lets Managers Pursue Their Own Aims

1. Owners want maximum profit and returns.
2. Managers may prefer growth, status or an easier life.
3. Because owners cannot fully monitor managers, these aims can diverge.

The Divorce of Ownership Opens the Door to Non-Profit Objectives

1. The divorce of ownership from control opens the door to non-profit aims.
2. Managers may target sales, growth or their own utility instead.
3. This is the root of the alternative objectives firms pursue.

Tie the Principal-Agent Problem to Asymmetric Information

Firms May Pursue Objectives Other than Maximum Profit

1. Firms may pursue objectives other than maximum profit.
2. These include profit satisficing, revenue maximisation and sales maximisation.
3. Others include growth, market share, managerial utility and social goals.

Satisficing, Revenue and Sales Maximisation Are the Main Alternatives

1. Satisficing: Managers aim for good-enough profit to satisfy a range of stakeholders (Simon).
2. Revenue and sales maximisation: Revenue maximisation sets $MR=0$, while sales maximisation pushes output to the break-even limit.
3. Growth and social goals: Firms may chase market share, size or ethical and environmental aims.

Each Objective Sits at a Different Output on the Diagram

1. Profit maximisation sits at $MC=MR$.
2. Revenue maximisation sits further right, where $MR=0$.
3. Sales-volume maximisation sits further right still, where $AR=AC$.

Do Firms Really Abandon Profit Maximisation?

1. The divorce of ownership from control does give managers room to pursue growth, sales or an easier life rather than maximum profit for owners.
2. But incentives such as performance-related pay and share options can realign managers with shareholders, pulling behaviour back towards profit.
3. The threat of takeover also disciplines managers, since a firm making low profit becomes a cheap target for a more profit-focused buyer.
4. Many apparently non-profit objectives serve profit in the long run anyway, since satisficing protects reputation while sales or growth build future market power.
5. So whether a firm truly departs from profit maximisation depends on how tightly owners can monitor and incentivise managers, and on the time horizon over which profit is judged.

Separate Revenue Maximisation from Sales-Volume Maximisation